Covid-19: Implications for Commercial Contracts under Italian Law
The outbreak of Covid-19 is having disruptive effects on trade and commerce in Italy (and around the world).
The question arises as to whether the outbreak and the related emergency measures adopted by the Government may excuse non-performance of commercial contracts. The answer will depend on the applicable law, the specific terms of the agreement, and the factual circumstances of the case.
For contracts governed by Italian law, these are the key aspects to consider based on both general principles of Italian contract law and on the new legislation adopted by the Government to respond to the emergency.
1. Has the Performance of the Contract Become Impossible?
“Nobody is held to the impossible”. Parties to a contract are discharged from their contractual obligations if performance has become objectively impossible due to a supervening and unforeseeable circumstance that is not attributable to the party. Relevant circumstances include both natural events and orders or prohibitions issued by public authorities (“factum principis”). Today, for instance, it might be impossible to deliver certain products that can no longer be manufactured due to the factories’ shutdown imposed by government restrictive measures. The obligation that becomes impossible to be performed ceases to exist because “nobody can be held to the impossible”.
Creditor may refuse performance. Italian courts are increasingly ready to apply the same rule when the obligation is still possible, but the creditor has no longer interest in it because external and unforeseeable circumstances prevent the creditor from making use of the counterparty’s performance (‘impossibility to benefit from the obligation’). If this happens, the creditor may refuse the performance (e.g. by refusing to receive the delivery) by invoking the extinction of the obligation. Conversely, parties cannot expect to be discharged from their payment obligations as these can hardly become ‘objectively’ impossible.
Termination of reciprocal contracts. In case of reciprocal contracts, the extinction of one party’s obligation determines the automatic termination of the entire contract. Upon termination, parties having performed or partially performed their obligations are entitled to restitution.
Temporary impossibility. If the impossibility is only temporary, the debtor is relieved from its obligation for the duration of the impediment and is not liable for late performance. The debtor is permanently released if the impediment lasts until the creditor has lost interest in the performance or the debtor, given the nature of the contract, can no longer be deemed bound.
Partial impossibility. If the impossibility is merely partial, the debtoris only bound by the portion of the obligation that is still possible. In reciprocal contracts, the counterparty is entitled to reduce its obligation so as to restore a balance between the parties’ positions. Alternatively, the counterparty may also withdraw from the contract if there is no material interest in the partial fulfilment of the other party’s obligation.
Can the Covid-19 outbreak trigger these remedies? The ongoing outbreak may be qualified as a cause of supervening impossibility due to its objective and unforeseeable character. Indeed, this has been confirmed by the new legislation enacted by the Government during the outbreak:
- for certain air travel, railroad and maritime contracts, the termination for supervening impossibility to perform has been conclusively established by law. Significantly, these provisions are expressly qualified as “overring mandatory norms” of Italian law. Accordingly, these provisions will always be applied by Italian courts regardless of the law governing the contract (Art. 28, Decree Law 2 March 2020, no. 9);
- for all contracts, the emergency legislation expressly provides that the restrictive measures must always be taken into account in assessing a potential breach of contract (Art. 91, Decree Law 17 March 2020, no. 18 “Cura Italia”).
Case-by-case assessment. The new emergency legislation confirms that the application of the statutory remedies (relief from obligation and termination of the contract) due to the Covid-19 outbreak is not automatic but it will need to be assessed on a case-by-case basis. The outbreak and the restrictive measures are surely capable of being qualified as causes of supervening impossibility to perform, but to be released from their obligations, parties shall still prove the concrete impact that these events had on the specific contract.
2. Has the Performance of the Contract Become Excessively Burdensome?
Although still possible, due to the Covid-19 outbreak performing the contract may have become more burdensome than could reasonably have been anticipated at the time of the conclusion of the contract. The general rule is that contracts remain binding despite changes in circumstances that may affect the position of the parties. Exceptionally, however, long-term contracts might be terminated if:
- exceptional and unforeseeable events occur during the duration of the contract; and
- these events make one of the parties’ performance excessively burdensome, so as to cause a party’s disproportionate sacrifice to the benefit of the other.
Remedies. In these situations, the affected party may seek termination of the contract. To avoid termination, the other party may offer to renegotiate the contract on fairer terms. The ongoing outbreak surely amounts to an exceptional and unforeseeable event. However, the assessment of whether the outbreak made an obligation excessively burdensome and entitles the party to terminate the contract will need to be done on a case-by case basis.
3. What Steps Should I Take Now?
Notify the Other Contracting Party. Under Italian law, parties have a general duty to act in good faith in the performance of the contract. Arguably, that entails informing the contractual partner of supervening adverse situations that may hinder or delay the performance of the contract. In these cases, it might also be advisable to offer fallback options and negotiate consensual solutions.
Keep Detailed Records. Unfortunately, that may not be enough to avoid disputes all together. Parties should therefore document (even more than usual!) the impediments met due to the Covid-19 outbreak, as well as the efforts made to overcome such obstacles and to liaise with the counterparty.
4. Negotiating New Agreements in the Time of Covid-19
Include contractual clauses. Parties concluding contracts in the coming weeks should consider including specific contractual clauses to expressly regulate the various issues that could arise during the ongoing outbreak. This will help to avoid interpretative uncertainty and to minimise the risk of disputes.
The specific content of such clauses will depend on each party’s position:
- the party bearing the higher risk of contractual breach may want to incorporate “force majeure” or hardship clauses that expressly qualify epidemics and pandemics as relevant circumstances (as the new 2020 ICC Force Majeure Clause does). Please consider, however, that these clauses might be of little use with respect to restrictive measures that are already in place or are currently foreseeable.
- conversely, the other party may be interested in insulating the contractual relationship from the outbreak by limiting the defences available to the counterparty.
An intermediate option might be to include a specific obligation to renegotiate the contract so to adapt the terms of the agreement to the developments of the pandemic.
A different legal landscape. For your new contracts, keep in mind that:
- statutory remedies such as termination for supervening impossibility or hardship may not be available. Both remedies aim to protect parties from supervening and unforeseeable changes in circumstances. For new contracts concluded after the beginning of the Covid-19 outbreak, Government restrictive measures may not amount to unforeseeable circumstances;
- new contracts should carefully take into account the restrictive measures. If the contractual obligations infringe the prohibitions imposed by the emergency legislation adopted by the Government, the contract may be (partially or completely) null and void for violation of a peremptory norm of law.